n-01-81.pdf

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Exempt Organizations
Section 529 Programs
Notice 2001-81
This notice provides guidance regarding certain recordkeeping, reporting, and
other requirements applicable to qualified tuition programs described in ' 529 of the
Internal Revenue Code, in light of certain amendments made to § 529 by the Economic
Growth and Tax Relief Reconciliation Act of 2001 (Pub. L. No. 107-16, 115 Stat. 38)
(EGTRRA).
Among other changes to ' 529, EGTRRA: (1) expands the definition of Aqualified
tuition program@ to include certain prepaid tuition programs established and maintained
by one or more eligible educational institutions; (2) provides an exclusion from gross
income for distributions from a State ' 529 program (and, beginning in 2004, a prepaid
tuition program established and maintained by one or more eligible educational
institutions) which are used to pay for qualified higher education expenses of the
designated beneficiary; (3) repeals the requirement that a ' 529 program impose a
more than de minimis penalty on any refund of earnings not used for qualified higher
education expenses of the beneficiary; and (4) replaces that penalty with an additional
10-percent tax on the amount of a distribution from a ' 529 program that is includible in
gross income (with certain exceptions). In general, these amendments are effective for
taxable years beginning after December 31, 2001.
1
In light of these changes, and to give ' 529 programs adequate time to
implement appropriate recordkeeping and reporting procedures, the Internal Revenue
Service and the Treasury Department are issuing this guidance, which they intend to
incorporate in final regulations under ' 529. Section 529 programs and their

1
Unless otherwise indicated, references herein are to § 529 of the Internal Revenue
Code, as amended by EGTRRA.

2
participants may rely on this notice pending the issuance of final regulations under §
529.
a. Imposition of a penalty and verification of purpose of a distribution.
As currently in effect (prior to the effective date of EGTRRA), ' 529(b)(3)
provides that a program is not treated as a qualified ' 529 program unless it imposes a
more than de minimis penalty on any refund of earnings that is not: (a) used for qualified
higher education expenses of the designated beneficiary; (b) made on account of the
death or disability of the designated beneficiary; or (c) made on account of certain
scholarships or other educational assistance received by the beneficiary. Prop. Treas.
Reg. ' 1.529-2(e) provides rules on de minimis penalties and procedures for verifying
the use of distributions and imposing and collecting penalties.
EGTRRA repeals ' 529(b)(3), effective for taxable years beginning after
December 31, 2001. Therefore, the final regulations under ' 529 will provide that, with
respect to any distributions made after December 31, 2001, a ' 529 program will no
longer be required to verify how distributions are used or to collect any penalty.
However, with respect to any distributions made on or before December 31, 2001, a '
529 program must continue to verify whether the distribution is used for qualified higher
education expenses of the beneficiary and to collect a more than de minimis penalty on
nonqualified distributions.
b.Reporting of distributions.
Section 529(d) provides that a ' 529 program shall make reports regarding the
program to the Internal Revenue Service and to designated beneficiaries regarding
contributions, distributions, and such other matters as the Internal Revenue Service
may require. Prop. Treas. Reg. ' 1.529-4 requires a State tuition program to report on
Form 1099-G, Certain Government Payments, the earnings portion of any distribution

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made during the year, together with other information such as the name, address and
TIN of the distributee. A § 529 program must furnish a statement to the distributee on
or before January 31
st
of the year following the calendar year in which the distribution is
made. In addition, a § 529 program must file Form 1099-G on or before February 28
th
of the year following the calendar year in which the distribution is made.
These reporting requirements continue in effect for distributions made in 2001.
Thus, with respect to any distributions made in 2001, a ' 529 program must furnish
statements to the distributees on or before January 31, 2002, and file returns on Form
1099-G on or before February 28, 2002.
In light of the expansion of ' 529 to include prepaid tuition programs established
and maintained by one or more eligible educational institutions (which may be private
institutions), the Internal Revenue Service will issue a new form, Form 1099-Q, for
taxable years beginning after December 31, 2001. A copy of Form 1099-Q is available
on the IRS website at www.irs.gov.
c. Calculation of earnings.
1. In general.
Section 529(c)(3)(A) provides that a distribution from a ' 529 program is
includible in the gross income of the distributee in the manner as provided under ' 72,
to the extent not excluded from gross income under any other provision of Chapter 1 of
the Code. Section 529(c)(3)(D)(iii) provides that, except to the extent provided by the
Secretary, the value of the contract, income on the contract, and the investment in the
contract are to be computed as of the close of the calendar year.
2. Recordkeeping requirements with respect to rollover contributions.
Section 529(b)(3)
2
states that a program must provide a separate accounting for

2
Section 529(b)(4) was renumbered as § 529(b)(3) by EGTRRA.

4
each designated beneficiary. Prop. Treas. Reg. ' 1.529-2(f) requires a ' 529 program
to maintain records with respect to the designated beneficiary of each account showing
the total investment in the account and any earnings attributable thereto.
In the case of a contribution to a ' 529 account that represents a transfer from a
Coverdell education savings account described in ' 530(b)(2)(B), a transfer of proceeds
of a qualified U.S. Savings Bond described in ' 135(c)(2)(C), or a Arollover@ of amounts
from another § 529 program account (each, a “rollover contribution”), the recipient ' 529
program must determine the basis and earnings portions of the amounts contributed.
(See Prop. Treas. Reg. ' 1.529-3(a)(2), which provides that the earnings portion of the
rollover amount must be added to the earnings of the account that received the
contribution.)
Although this requirement was not changed by EGTRRA, § 529 programs have
indicated that there is some confusion about the requirement that a § 529 program
determine and maintain records that reflect the basis and earnings portions of any
rollover contribution. Accordingly, it is expected that final regulations will clarify that,
when accepting a contribution, a § 529 program must ask whether the contribution is a
rollover contribution from a Coverdell education savings account, a qualified U.S.
Savings Bond, or another § 529 program. If the contribution is a rollover contribution,
the § 529 program must determine the earnings portion of the contribution, and add that
amount to the earnings recorded in the account to which the rollover contribution is
made. Until the § 529 program receives appropriate documentation showing the
earnings portion of the contribution, the program must treat the entire amount of the
contribution as earnings in the § 529 account receiving the distribution. For this
purpose, “appropriate documentation” means: (1) in the case of a rollover contribution
from a Coverdell education savings account, an account statement issued by the

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financial institution that acted as trustee or custodian of the education savings account
that shows basis and earnings in the account; (2) in the case of a rollover contribution
from the redemption of qualified U.S. Savings Bonds, an account statement or Form
1099-INT issued by the financial institution that redeemed the bonds showing interest
from the redemption of the bonds; and (3) in the case of a rollover contribution from
another § 529 program, a statement issued by the distributing § 529 program that
shows the earnings portion of the distribution.
3. Rollover statement between § 529 programs.
In the case of any direct transfer (i.e., trustee-to-trustee rollover) between § 529
programs, the distributing program must provide to the receiving program a statement
setting forth the earnings portion of the rollover distribution within 30 days after the
distribution or by January 10
th
of the year following the calendar year in which the
rollover occurred, whichever is earlier. This rule is effective for direct transfers between
§ 529 programs that occur on or after January 1, 2002.
4. Timing of earnings calculation.
Consistent with § 529(c)(3)(D), the proposed regulations provide that the
earnings portion of any distribution is determined by applying an earnings ratio,
generally the earnings allocable to an account as of the close of the year divided by the
total account balance as of the close of the calendar year, determined by adding back
the amount of all distributions made during the year. See Prop. Treas. Reg. § 1.529-
1(c).
In response to comments received on the proposed regulations, and consistent
with the Secretary’s authority under § 529(c)(3)(D)(iii) to adopt a different rule, the
Treasury Department and the Internal Revenue Service expect that final regulations will
revise the time for determining the earnings portion of any distribution from a § 529

6
account. It is expected that final regulations will provide that, effective for distributions
made after December 31, 2002, programs will be required to determine the earnings
portion of each distribution as of the date of distribution. In the case of direct transfers
between § 529 programs, this requirement is effective for distributions made after
December 31, 2001. In the case of any State program for which this change would
require legislation and whose State legislature has a biennial legislative session, the
program will have until January 1, 2004, to conform to this method of calculating
earnings.
5. Aggregation of Accounts.
Section 529 (c)(3)(D)(i) provides that to the extent provided by the Secretary, all
§ 529 programs of which an individual is a designated beneficiary shall be treated as
one program. Prop. Treas. Reg. § 1.529-3(d) provides that all accounts maintained by
a § 529 program for the benefit of a designated beneficiary shall be treated as a single
account for purposes of calculating the earnings portion of any distribution. Based on
comments received on the proposed regulations, it is expected that the final regulations
will provide that only accounts maintained by a § 529 program and having the same
account owner and the same designated beneficiary must be aggregated for purposes
of computing the earnings portion of any distribution. For this purpose, a State that has
both a prepaid § 529 program and a § 529 savings program should consider each
program separately for purposes of calculating the earnings portion of any distribution
from either the prepaid or the savings program. These changes will apply for purposes
of the earnings calculation only, and will not affect the application of § 529(b)(6)
(prohibition on excess contributions)
3
. The § 529(b)(6) limit will continue to be applied
based upon all accounts, both savings and prepaid, in programs established and

3
Section 529(b)(7) was renumbered as § 529(b)(6) by EGTRRA.

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maintained by the State for the benefit of the same designated beneficiary.
Comments on Future Guidance Invited
The Internal Revenue Service invites comments on the matters described in this
notice and any other matters relating to § 529 and the regulations thereunder. Please
send written comments by March 25, 2002, to: CC:ITA:RU (Notice 2001-81), room
5226, Internal Revenue Service, POB 7604, Ben Franklin Station, Washington DC
20044. Submission may be hand-delivered Monday through Friday between the hours
of 8 a.m. and 5 p.m. to CC:ITA:RU (Notice 2001-81), Courier’s Desk, Internal Revenue
Service, 1111 Constitution Avenue, NW, Washington DC. Alternatively, taxpayers may
submit comments electronically via the Internet by selecting the “Tax Regs” option on
the IRS Home Page, or by submitting comments directly to the IRS Internet site at
http://www.irs.gov/prod/tax_regs/regslist.html. Comments will be available for public
inspection.
DRAFTING INFORMATION
The principal author of this notice is Monice Rosenbaum of the Office of Division
Counsel/Associate Chief Counsel (Tax Exempt and Government Entities). For further
information regarding this notice contact Ms. Rosenbaum at (202) 622-6070 (not a toll-
free number).